Zeljko Ranogajec the mug punter and tax issues

Taxation of Income Derived from Gambling
by Rob Meredith

Background

It’s commonly understood in Australia that income derived from gambling is not taxable.  This is certainly true of many forms of gambling winnings, such as lottery winnings, casual casino game (e.g. poker machines, roulette) players who manage to make a short-term profit, and many other forms of purely luck based games.  However the line starts to blur in those games where a consistent long-term profit is achievable through the application of skill.  Particular examples of games where this is possible include blackjack, poker and sports betting.

Historically, the ATO has rarely pursued individuals for profits derived from gambling activities.  The recent furore involving the ATO and David Walsh (creator of MONA) may be indicative of the ATO taking a more aggressive approach in identifying and targeting individuals who derive a significant portion of their income from gambling.

The Law

Taxation law in Australia is governed by the Income Tax Assessment Act 1997 (‘ITAA97’), and it’s predecessor, the Income Tax Assessment Act 1936 (‘ITAA36’)

Section 6-5(1) of the ITAA97 provides that the assessable income of a taxpayer includes income according to ordinary concepts.  An amount is ordinary income if it has its source in an earning activity.  The earning activity may be either labour, investment, or labour and investment combined in the carrying on of a business.  “Income from business” is not defined in either ITAA36 or ITAA97, although “business” is defined as “including any profession, trade, employment, vocation or calling, but does not include occupation as an employee” (s6(1) ITAA36; 995-1 ITAA97).

Where a person engages in gambling activities, if those activities constitute the carrying on of a business, then the profit or losses derived from those activities are ordinary income, and form part of a taxpayer’s assessable income.

What is a business?

In FCT v Murry (1998) 193 CLR 605 at [54], Gaudron, McHugh, Gummow and Hayne JJ said:

    “A business is not a thing or things.  It is a course of conduct carried on for the purposes of profit and involves notions of continuity and repetition of actions.”

The question of whether particular activities constitute a business is one of fact and degree.  Hill J summarised the position in Evans v Federal Commissioner of Taxation (1989) 20 ATR 922 at 96-98 as follows:-

    ‘The question of whether a particular activity constitutes a business is often a difficult one involving as it does questions of fact and degree. Although both parties referred me to comments made in decided cases, each of the cases depends upon its own facts and in the ultimate is unhelpful in the resolution of some other and different fact situation.

    There is no one factor that is decisive of whether a particular activity constitutes a business. As Jessel MR said in the famous dictum in Ericksen v. Last (1881) 8 QBD 414 at p 416:

    “There is not, I think, any principle of law which lays down what carrying on trade is. There are a multitude of things which together make up the carrying on of trade.”

    Profit motive, scale of activity, whether ordinary commercial principles are applied characteristic of the line of business in which the venture is carried on, repetition and a permanent character, continuity, and system are all indicia to be considered as a whole, although the absence of any one will not necessarily result in the conclusion that no business is carried on.’

More recently, in Spriggs & Riddell v FCT (2009) 239 CLR 1 at [59], the High Court observed that the “existence of a business is a matter of fact and degree.  It will depend on a number of indicia, which must be considered in combination and as a whole.  No one factor is necessarily determinative”.

In Brajkovich v Federal Commissioner of Taxation [1989] FCA 454 at [35], their Honours Pincus, Gummow and French JJ identified the principal criteria on which questions of whether gambling will be classified as a business:

    whether the betting is conducted in a systematic, organised and “businesslike” way;
    its scale: i.e. the size of the wins and losses;
    whether the betting is related to, or part of, other activities of a business-like character, e.g. breeding horses;
    whether the bettor appears to engage in his activity principally for profit or principally for pleasure;
    whether the form of betting chosen is likely to reward skill and judgment or depends purely on chance;
    whether the gambling activity in question is of a kind which is ordinarily thought of as a hobby or pastime.

The joint judgment went on to say that gambling that involves a significant element of skill (e.g. a professional golfer betting on himself), is more likely to have tax consequences than gambling on merely relevant events.  The difference between roulette, in which a player has a very low probability of winning over the long-term, regardless of how they bet, and poker, in which a player with a skill advantage over his competition will usually win in the long-term, is a significant one.

In Woellner et al Australian Taxation Law (2010) at page 260, the authors conclude that where activities have the “prima facie flavour of a hobby”, as with betting, the courts require much stronger evidence of system and organisation than would otherwise be required to find that the activities constitute a business:

As the Full Federal Court observed in Brajkovich v FCT (1989) 20 ATR 1570, it may be said ‘more as a matter of usage than logic’, that the gambler who seeks to demonstrate that he or she is in the business of betting has to show more by way of system and profit motive than those who engage in ‘more conventionally commercial’ activities. The courts’ approach reflects not only the strong influence of chance and luck involved in gambling, but also perhaps an assumption that the personal or private pleasure which many persons derive from betting on horse racing and other racing as a pastime or hobby provides a ready explanation for even large-scale betting activity.

In Evans, the taxpayer engaged in regular and frequent gambling on horses and greyhounds making profits ranging from $90,000 in 1978 to $430,000 in 1980. The court held he was not carrying on a business of gambling. Hill J said at 114:

    [Evans] did not spend large amounts of time studying form; he subscribed to no tipping or information services; had no sources of information such as trainers. He made no attempt to work out combinations of bets designed to give him a positive result or limit his exposure to risk; he made no use of technology such as computers; did not go about calculating odds nor ensuring that in his bets he got the best odds. His gambling was undertaken not in accordance with a preformulated plan but as the mood took him. He had no allocated capital with which to conduct his activity and kept no record of his winnings or losses.

The question of whether gambling activities constitute a business, and whether the profits (or losses) form part of a taxpayer’s assessable income, is largely dependent on the level of system or methodology adopted by the person in carrying out those activities.

At one end of the scale, you have the thousands of people across Australia that occasionally dabble in gambling as a hobby.  There is no doubt that the wins or losses of those people are not to be treated as part of their assessable income.  At the other end of the scale, you have sophisticated gambling syndicates, who may wager up to a $1b on racing every year, and generate enormous profits.  Somewhere in the middle, you have people such as self-styled professional poker players, who often generate modest incomes, but use a wealth of specific tools to track and analyse their play, and spend significant amounts of time studying and devising mathematical models to increase their edge against opponents.  It’s not clear whether those people are engaged in business, but if the ATO’s recent move against high-net worth individuals is indicative, it may not be long until the courts have an opportunity to take a much closer look at the law in this area.